Winning battles, rather than the war, on economic development subsidies

Editorial

With the publication of its 1994 Annual
Report, the Federal Reserve Bank of Minneapolis took a formal position
in the debate surrounding the use of public subsidies for private businesses.
Readers of the fedgazette know this bank has opposed such
preferential treatment, arguing that only Congress—under its power
within the Commerce Clause of the Constitution—has the ability to
address this issue on a national scale. Since that time, we have taken
a fairly active role in this debate.

Most recently, we have taken a close look at economic development
programs and policies from Montana to the Upper Peninsula of Michigan
in the April and July
issues of the fedgazette, including an informal
survey of economic development officials in the Ninth District.

During the course of research for these articles, a few comments
and themes came up repeatedly from local development practitioners,
and deserve some discussion.

Incentives to businesses are a good thing because they create
new jobs for local citizens. Yes, from a purely local point
of view, that can be true. Attracting or retaining jobs for a particular
community—if those jobs would ultimately end up somewhere else—makes
sense. To a degree, communities must engage in these subsidy battles
as long as such business incentives are the norm. While it might
be noble and principled, unilateral withdrawal from the incentive
competition is tantamount to community martyrdom.

Nevertheless, the benefits of these battles are often overstated.
To justify the use of incentives, cities quickly point to the number
of business expansions and new jobs they've created with the use
of incentives. Those same cities, however, have also been on the
losing end of that incentive competition. Rarely is a larger scorecard
kept, one that tallies both wins and losses over time and geographic
space. Neither do cities thoroughly assess whether economic expansion
would have occurred in some fashion without the use of incentives.

These individual local skirmishes also are not an end game. The
war is large scale and long term, and it is at this level that the
use of incentives is ultimately ineffective and unproductive. If
Rapid City, S.D., for example, lures a company from Sioux Falls,
S.D., that may be good for Rapid City, but what has the state of
South Dakota gained? And if Sioux Falls attracts a company from
Fargo, N.D., what is the benefit to the country? Perspective matters
in this debate; the broader a perspective you take, the more this
economic war becomes a zero-sum game, at best.

Business incentives are a good way to counter-balance a poor
business climate. While seemingly a pro-business stance, in
fact incentives compound a poor business climate. The best way to
counter a poor business climate is to change that climate across
the board, rather than grant exemptions from it for a few lucky
businesses.

When people talk about a poor business climate-be it local or
state-they generally mean that business taxes are too high. The
answer to this problem is not to give preferential treatment to
certain businesses, but to reduce the tax burden for all businesses.
Indeed, incentives exacerbate a poor business climate by requiring
existing businesses to bear the cost of incentives given to a handful
of companies-some of whom might be their competitors.

Incentives aren't the deciding factor in business locations—they
aren't the "deal closers"—so why all the fuss? Quite simply,
you can't have it both ways: If preferential subsidies don't matter,
then why use them? Studies show that, on average, this assertion
is true and incentives are not, in the end, the deal closers. But
this only suggests that there is a fair amount of bluffing going
on among companies and their suitors.

If most bargaining is just a ruse, then public funds merely go
to encourage and reward the practice. In the end, finite public
resources will have been used to facilitate private economic activity
that would have occurred anyway, and the public loses.

As long as incentives are an ingrained part of the "location
market," what's the harm if everyone provides them? Three reasons:

If one company gets preferential treatment, it is unfair to existing
businesses, some of whom may be competitors with the newcomer.

While incentives are often not the deciding factor in location decisions,
as previously discussed, they sometimes do affect the end location
and result in an inefficient outcome.

Taking the broader perspective, the economic bidding war consumes
finite resources that should be used for public goods like schools,
roads and public protection. If there were no economic bidding war,
there would be more revenue for the basic public goods, or a lower
overall tax burden.

If you take away incentive tools, rural areas will not be able
to compete with larger metropolitan areas. This argument presupposes
that rural areas, on average, are faring well in the economic bidding
war. Most evidence and opinion suggests they are not. Rural development
professionals regularly point out that they are easily and often
outbid by larger cities and metro areas with more resources, particularly
for larger business projects. Somewhat ironically, many nonetheless
believe that rural areas would be the losers in ending the competition
over incentives.

Such a viewpoint—that incentives help stem rural loses—is
patronizing to rural areas, and assumes that the only reason a company
would move to a small town is because of preferential incentives.
If rural areas are luring businesses to their locations, it is likely
because of the local labor force, quality of life, geography and
other criteria. A level playing field—one without the artificial
competition of incentives—would likely enhance those positive
rural attributes.

OK, for argument's sake, let's assume there is a problem. Why
get the federal government involved? Congress has no right to
tell local governments how to operate in these matters. However,
Congress does have the right to regulate interstate commerce, especially
in these matters, because state and local governments are interfering
with interstate commerce.

On their own, local governments won't—indeed, can't—stop
using subsidies and preferential taxes to attract and retain businesses.
As long as a single state engages in this practice, others will
feel compelled to compete. Only Congress, under the Commerce Clause
of the Constitution, has the power to enact legislation to prohibit
states from using subsidies and preferential taxes to compete with
one another for businesses.

To address this issue, a bill
by Rep. David Minge (D-Minn.) has been presented to Congress that
would apply a confiscatory tax to all preferential subsidies, thus
rendering them useless as an incentive tool. Such a bill would not
only put an end to the economic subsidy war, but would also allow
local governments to make better use of their public funds and to
create an attractive business environment based on general tax rates,
education and infrastructure.

The answer to local economic development is not to give awards
to preferred businesses and suffer the rest to carry the burden,
but to create a general business climate conducive to economic growth.